Coverage for Colorado Construction Defect Claims: Update on the Aftermath of General Security

By: Christopher R. Mosley, Jerome H. Sturhahn and Katherine D. Varholak

Courts around the country continue to disagree on the question whether a commercial general liability policy covers construction defect claims. This advisory provides an update on two recent federal decisions issued in the aftermath of General Security Indem. Co. v. Mountain States Mutual Cas. Co. [1]

In General Security, a panel of the Colorado Court of Appeals held that a general liability policy does not cover claims of defective workmanship that involve only damage to the insured's work, reasoning that that poor work, standing alone, is not an accident that constitutes a covered occurrence.[2] General Security left an opening for coverage for those defect claims alleging resulting or "consequential" damage stemming from the poor work. The General Security court did not define "consequential damage", but stated that covered consequential damage could include damage to the home or structure outside the scope of work of the particular subcontractor responsible for the defects.

In the wake of General Security, two federal courts in Colorado applied General Security with conflicting results. In Greystone Construction, Inc. v National Fire & Marine Ins. Co., a federal District Court judge held that faulty workmanship of a general contractor is a covered occurrence only when it causes consequential damages to something other than the work itself. With respect to a general contractor, the court considered damage anywhere on the project to be damage to "the work itself" regardless of the specific scope of work alleged to be defective. Thus, under Greystone, poor workmanship resulting in damage to the home under construction is not a covered occurrence, whereas poor work resulting in damage to personal property or damage to a neighbor's house is a covered occurrence. An appeal of the Greystone decision is currently pending.

By contrast, in American Family Mutual Insurance Co. v. Teamcorp, Inc., a different federal District Court judge concluded that claims for deficient design were covered under a CGL policy because the "overall problems" with the house under construction (necessitating its demolition) were consequential damages. The court also stated that, absent a design exclusion, poor design is a covered occurrence where it leads to faulty construction or the inability of the homeowner to use the home.

Thus, General Security, Teamcorp and Greystone conflict on what is considered uncovered damage to "the work itself" and what is considered covered "consequential damage" caused by the defective work.

What This Means To You

Colorado law on construction defect coverage will remain in state of flux until the Colorado Supreme Court weighs in on the issue. Unfortunately, recent federal decisions on the subject still largely favor the insurance industry. The federal decisions are not binding on Colorado courts in a technical sense, but insurers are already relying on them to deny or limit coverage for construction defect claims.

What can you do to minimize the impact of General Security and its companion federal cases? First, plan ahead. If you are in the construction industry, work with your insurance broker during renewal to ask whether the insurer considers faulty workmanship to be an occurrence. Be wary of those insurers who refuse to answer this question. Obtain commitments, in writing, from those who indicate it will be covered.

Second, if you are involved in a construction defect claim, consider the following strategies to challenge an insurer who raises General Security as a defense. Advise the insurer that General Security is not the law of Colorado, as it conflicts with Monterra Homes, an earlier decision of the Court of Appeals. Moreover, Greystone and Teamcorp are federal decisions, which are not binding on Colorado courts.

In addition, your counsel should consider carefully how to address the key issue of consequential damages in your insurance claims and in any ensuing litigation. The question of which damages are considered to be "consequential" appears to be a critical battleground on the coverage front.

[1] General Sec. Indem. Co. of Arizona v. Mountain States Mut. Cas. Co., 205 P.3d 259 (Colo. App. 2009).

[2] General Security conflicts with a 2005 opinion from a separate panel of the Colorado Court of Appeals in Hoang v. Monterra Homes, LLC, 129 P.3d 1028 (Colo. App. 2005), rev'd on other grounds sub nom. Hoang v. Assurance Co. of Am., 149 P.3d 798 (Colo. 2007), which concluded that, in general, CGL policies cover construction defect claims.

Attorneys in the Sherman & Howard Insurance Recovery Practice Group are available to assist with these and other issues.

Sherman & Howard has prepared this advisory to provide general information on recent legal developments that may be of interest. This advisory does not provide legal advice for any specific situation. This does not create an attorney-client relationship between any reader and the firm. If you want legal advice on a specific situation, you must speak with one of our lawyers and reach an express agreement for legal representation.